Thursday, February 25, 2010

Foreign Aid: A Policy in Search of a Rationale

In a review of a book by Zambian economist Dambisa Moyo, in the January issue of Foreign Affairs, Jagdish Bhagwati retraces a short and striking history of the doctrine of aid to development. It has been surprisingly shallow from the start and resting on extremely weak arguments.

The first one was the charity argument, but international altruism proved quite limited. Then followed the Cold War argument: if western nations did not give aid, the Soviet Union would do it, with dire consequences. But the catch was that it was then inevitable that much of the aid would end up in the hands of unsavory regimes that pledged to be anticommunist, but would use the funds for sumptuary spending. The self-interest argument (The Pearson Commission, 1968; the Brandt Commission, 1977) of doing well by doing good then followed. It was based on a crude Keynesian assertion that made no sense at all: raising global demand for goods and services through aid to poor countries would reduce unemployment in the rich countries. But obviously spending that money directly in the rich countries would reduce unemployment even more. Nowadays, the aim of limiting illegal immigration is taking center stage, but it neglects the fact that the primary constraint on illegal immigration, writes Bhagwati, is the inability of many aspiring immigrants to pay the smugglers who guide them across the borders. If paid higher salaries at home, they would have an even easier time paying “coyotes”, and more of them would attempt illegal entry.

Moreover, the provision of aid creates perverse incentives and unintended consequences. For instance the Harrod-Domar model widely used throughout the 1970s, which says that in order to get a target rate of growth one has to invest a target investment level, and for that reach a target savings rate. But if aid furnishes the funds for investment, then the problem is that, in practice, it led to reduced domestic savings. Many aid recipients were smart enough to realize that once wealthy nations had made a commitment to support them, shortfalls in their domestic efforts would be compensated by increased, not diminished, aid flows. The classical moral hazard problem.

Aid not only did not work, but it cannot work concludes Bhagwati following Moyo. On the other hand:

“After countries such as China and India changed course and adopted liberal (or, if you prefer, "neoliberal") reforms in the last decades of the century, their growth rates soared and half a billion people managed to move above the poverty line -- without question, the greatest and quickest progress in fighting poverty in history.Neither China nor India, Moyo points out, owed their progress to aid inflows at all. True, India had used aid well, but for decades its growth was inhibited by bad policies, and it was only when aid had become negligible and its economic policies improved in the early 1990s that its economy boomed. The same goes for China.

If history is any guide, therefore, the chief weapon in the "war on poverty" should be not aid but liberal policy reforms. Aid may assist poor nations if it is effectively tied to the adoption of sound development policies.”

Dambisa Moyo, a young Zambian-born economist educated at Harvard and Oxford and employed by Goldman Sachs and the World Bank, is highly critical of how rock stars, such as Bono,Holywood actresses and globetrotting troubadours have dominated the public discussion of aid and development in recent years, to the exclusion of Africans with experience and expertise. She sometimes goes too far according to Bhagwati, for instance when she proposes terminating all aids within five years. But she is also healthily skeptical of academic proponents of aid, such as her former Harvard professor Jeffrey Sachs, and other activists. Instead, she dedicates her book to a prescient early critic of aid, the development economist Peter Bauer.

Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa. By Dambisa Moyo. Farrar, Straus & Giroux, 2009, 208 pp. $24.00.

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About Me

As a professor of economics, my main specialization fields are in the theory and strategy of the firm, and the theory and applications of public choice (political economy).
I also do consulting work in these fields.
For more information on my work go to my homepage: http://jeanjacques.rosa.pagesperso-orange.fr/
and my SSRN author page: http://ssrn.com/author=471576.
My e-mail has changed: jj.rosa@orange.fr